Airline Stocks: 2 to Book, 2 to Bump

by Susan J. Aluise | February 6, 2014 10:58 am

Airline Stocks: 2 to Book, 2 to Bump

The airline industry is an infamously difficult place to make money. As Warren Buffett once observed: “If a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.”

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Source: Flickr[2]

But despite the sector’s slim margins, vulnerability to fuel price swings and soaring aircraft and labor costs, airline investors did very well for themselves last year as airline stocks delivered gains of 50% to more than 100%.

However, investors should emphasize two of those words above all others: “last year.” Airline stocks will not post anything near 2013′s eye-popping returns this year.

That said, airline stocks learned a lot battling through the Great Recession — lessons that included fuel efficiency and hedging, rigorous capacity planning, higher ticket prices and an aggressive focus on new revenue streams like baggage and other ancillary fees.

But despite last year’s run-up in share prices, some airline stocks still boast attractive multiples and their overall business strategies look particularly promising this year, while some perennial performers look likely to hit a patch of turbulence in 2014. Here are two airline stocks that have further to fly and two that should buckle up for a bumpy ride:

Book: United Continental Airlines (UAL)

[3]United Continental Airlines (UAL[4]) CEO Jeff Smisek is willing to ruffle feathers to enhance United’s ability to compete — a fact vividly illustrated by the airline’s decision this week to drop its Cleveland hub, which has been a drain on earnings for the past decade.

After being plagued by myriad problems integrating the 2010 merger of United and Continental, UAL finally got up off the mat in the fourth quarter. The airline reported a profit of $140 million, or 37 cents per share, compared with a year-earlier loss of $620 million, or $1.87 per share; the carrier’s fourth-quarter revenue rose by more than 7% to $9.33 billion.

Despite storms, strong December traffic and adept capacity planning helped the airline deliver a nearly 12% increase in the all-important passenger revenue per available seat mile (PRASM) metric. UAL is up nearly 80% in the past year, but it’s still trading at less than 8 times forward earnings and has a price to earnings growth (PEG) ratio of only 0.26.

The attractive valuation compared to other airline stocks, combined with the fact that UAL finally has its act together from the integration mess last year and is posting a profit, make it likely that UAL will gain altitude in 2014.

Book: Delta Air Lines (DAL)

[5]It’s clear that Delta Air Lines (DAL[6]) CEO Richard Anderson has DAL firing on all thrusters. Last month, Delta reported earnings of 65 cents per share for the quarter — more than double the 28 cents per share it reported a year earlier, on revenue of $9.08 billion. Those numbers beat the Street on the top and bottom lines.

Looking ahead to the next quarter, DAL expects to expand margins between 6-8%; the airline also expects to boost PRASM by 3-4% in the current quarter. The company’s strategy has been a productive mix of fare and ancillary fee hikes, capacity planning and unconventional approaches to reducing jet fuel costs.

The Pennsylvania oil refinery DAL purchased in 2012 finally turned a tiny profit in the third quarter of last year — the company believes that refining lower cost Bakken crude into jet fuel will help the refinery turn solidly to the black in 2014.

Delta shares have gained 117% over the past year — an amazing run, even among airline stocks — which will give new investors pause. However, DAL is still trading at less than 10x forward earnings and has a PEG ratio of 0.8, indicating it could be slightly undervalued.

Bump: Southwest Airlines (LUV)

[7]Southwest Airlines (LUV[8]) delivered record earnings in the fourth quarter — 30 cents per share, compared to just 11 cents a share for the same quarter in 2012. That said, LUV stock, Wall Street’s favorite of the airline stocks, is likely to get walloped this year.

The carrier won big when it picked up the lion’s share of the slots the new American Airlines (AAL[9]) had to divest at Washington D.C.’s Regan airport. However, LUV is facing headwinds from its strategy shift to international, as well as growing pains from its AirTran integration this year.

LUV is struggling to grow into a legacy model, and the AirTran integration and half-billion dollar international reservations system (not to mention the international expansion itself) is likely to eat its lunch in the near term.

LUV has soared 84% over the past year, but the air is looking thin at that altitude. That’s evident by the forward P/E of more than 13 — one of the highest among airline stocks.

Bump: American Airlines (AAL)

[10]The new American Airlines (AAL[9]) has arrived, rewarding Doug Parker’s high-stakes courtship with the honor of running the largest carrier. But what’s in store for this behemoth among airline stocks?

AAL has hit the ground running on its integration plan, announcing this week that American and US Airways have extended their codeshares to most flights across their combined global network. By the end of the first quarter, the airlines each expect to sell tickets on flights operated by the other carrier using its own code and flight number.

This kind of integration is always a benefit because it’s easier for passengers to select and combine flights operated by each airline on a single itinerary. That said, count on passenger grumbles, particularly as passengers come to terms with US Air’s exit from the Star Alliance at the end of March.

While American’s OneWorld Alliance eventually will be a boon to frequent flyers, expect some frustration when US Air frequent flyers can no longer use their miles on Lufthansa, United Continental or other Star Alliance member carriers.

The merged US Air-American is a force to be reckoned with, but honeymoons are notoriously short when it comes to airline mega-marriages. Although AAL’s valuation is cheaper than rival airline stocks with a forward P/E of just 6.5, I think the new AAL has flown as high as it can for now.

As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.